TMFPencils (99.83)

Pencils IRA Purchase: RetailMeNot (SALE)

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When it comes to shopping, people love discounts. Retailers also love attracting new customers. RetailMeNot (SALE) helps both parties meet in the middle -- whether through its website or mobile app -- and has already grown sales more than 12 times over the past four years. For the five reasons explored below, I believe RetailMeNot's growth story is just getting started and offers an opportunity for patient investors to enjoy market-beating returns over the long run.

1. Purpose-driven business

RetailMeNot oversees a platform where customers looking for deals are matched with retailers offering discounts. Whether it be digital coupons or other deals, RetailMeNot's network grew to more than 60,000 retailers and brands offering deals to customers in 2013. Consumers want deals and retailers want to offer deals to attract consumers. RetailMeNot -- today the world's largest digital coupons marketplace -- operates a platform which serves as a win-win for consumers and retailers alike.

Founder and CEO Cotter Cunningham explains that the company's mission "is to be the number one place where consumers go to find the best offers, whether shopping online or at a store." Says Cunningham:

"We continue to reinforce our leadership position by not only helping consumers find our best digital coupons, but also creating an efficient channel for leading retailers to engage with a large, enthusiastic audience."

Boiled down to its simplest form, RetailMeNot's purpose is to help consumers save money by matching them with retailers offering discounts and deals.

2. Innovative products and services

The beauty of RetailMeNot is the company's growing network of retailers and brands offering deals to consumers. "We have created a marketplace for retailers to drive sales by showcasing their offers to consumers," says Cunningham. According to Cunningham, each consumer saves $20 on average through RetailMeNot. In contrast to Groupon, which Cunningham describes as a platform where small businesses give big discounts sporadically, RetailMeNot helps big businesses -- including Southwest Airlines, Starbucks, and Macy's -- give small discounts everyday. With more than 560 million visits to its website in 2013 (up from 350 million in 2011) and 16 million downloads of its mobile app, RetailMeNot is clicking in consumer engagement.

The RetailMeNot portfolio also includes Voucher Codes, the largest digital coupons marketplace in the United Kingdom, in addition to several other URLs and businesses in countries such as Germany, the Netherlands, and France. All have the same basic function: helping match consumers with the best deals from their favorite retailers and brands. Deals and discounts appeal to consumers around the world, and RetailMeNot is tapping into this global market.

There is especially extensive potential for RetailMeNot in the mobile market. "Now that more than 50 percent of American adults are smartphone owners," says Michael McGuire, research vice president at Gartner, "marketers are compelled to develop mobile strategies that ensure their products and services can be found, and purchased, by consumers on the go." An April 2014 survey from Gartner found that companies allocate on average 28.5% of their total marketing budget to digital marketing, up 20% from 2012 levels. Digital marketing spending is expected to increase 10% in 2014.

Customers with RetailMeNot's mobile app are notified when they are in the proximity of retailers offering deals, in addition to having the opportunity to conveniently search for deals on the go. Revenue through mobile devices now represents 15% of RetailMeNot's overall sales, with mobile revenue increasing127% year-over-year in the first quarter of 2014. Mobile app sessions skyrocketed to 125.3 million in the first quarter of 2014 from 20.2 million in the same period last year.

RetailMeNot stands to benefit as more retailers and brands engage in ever-increasing volumes of digital marketing. Winterberry Group, a marketing consulting firm, projects digital ad spending to top more than $50 billion in 2014. Over the next five years, do you think more or less marketing dollars will go toward digital marketing? Think about it. I expect current trends to continue and anticipate growing digital marketing spending in the years ahead. If this is indeed the case, RetailMeNot presents a timely opportunity for patient investors to take advantage of a marketing industry evolving toward the digital market.

3. Visionary, experienced, involved leadership

President and CEO Cotter Cunningham founded RetailMeNot in 2009. Formerly the COO of Bankrate.com, Cunningham began to "develop a hypothesis and business plan around the online coupon industry." The formation of RetailMeNot soon followed, and the company continues to grow its global presence as the top destination for consumers looking for deals and discounts.

While RetailMeNot is a young company, the business itself is overseen by a variety of experienced leaders. CFO Douglas Jeffries brings executive experience from Palm and eBay, while CTO Paul Rogers was an engineer at Google and has worked with RetailMeNot since the company's inception. The company's board of directors includes Gokul Rajaram, product engineering lead at Square, a commerce company perhaps best known for its mobile credit card reader for Apple and Android products. Rajaram also served as an advertising director for Facebook and was the Product Management Director for Google Adsense. Brian Sharples, the co-founder and CEO of HomeAway, a leading marketplace of vacation rentals worldwide, also serves on RetailMeNot's board.

All but three of RetailMeNot's executives and board members are under the age of 50, and bring with them a slew of experience related to eCommerce, advertising and marketing, and developing vibrant marketplaces online. Management continues to focus on research and development, with total funds allocated to product development increasing from $4.39 million in 2011 to $30.37 million in 2013. So far in 2014 product development spending has increased 80% year-over-year to $10.71 million.

In addition to focusing on innovation, management recognizes the value RetailMeNot brings to retailers and brands around the world. Marketers will follow the eyeballs, and as RetailMeNot racks up more visitors each quarter the network becomes all the more valuable to current and potential retailers looking to attract consumers with deals and discounts. Building relationships with retailers, therefore, is very important for the long-term success of RetailMeNot. RetailMeNot recently entered a strategic partnership with General Growth Properties (GGP), a real estate investment trust whose portfolio includes 120 malls in 40 states. This partnership will boost brand awareness by making RetailMeNot the "preferred digital coupon provider across GGP malls."

This focus on innovation overseen by an experienced leadership team -- which also recognizes the importance of strategic partnerships -- bodes well for the future of RetailMeNot.

4. Consistently increasing cash-flow production

RetailMeNot has been free cash flow positive over the past four fiscal years, and the company itself just went public in July 2013. The company grew operating cash flow from $2.61 million in fiscal year 2010 to $31.53 million in the 2013 fiscal year, producing $25.04 million in free cash flow over the course of the year. While the company's cash flow production hasn't been increasing in a straight line -- as is often the case for young and growing businesses -- RetailMeNot continues to produce solid free cash flow, helping build a sturdy balance sheet with $196.47 million in cash and $39.56 million in debt.

RetailMeNot has grown sales at an average annual pace of 87.83% over the past four years to $209.84 million in 2013, with sales increasing 51% in the first quarter of 2014. Most importantly, RetailMeNot has become more effective when it comes to translating customer visits to its website and mobile app into sales. Net revenues per visit increased from $0.16 in 2010 to $0.37 in 2013 and reached $0.39 in the first quarter of 2014.

5. Strong company culture

"We believe people work hard for us," says founder and CEO Cotter Cunningham, "so we need to work hard for them." RetailMeNot delivers on this promise to employees. Whether it be perks such as free meals offered each workday to employees, fun employee outings (go-kart racing, anyone?), or weekly company-wide "transparency meetings" to go over month-to-date sales and other metrics, RetailMeNot’s culture has translated to strong ratings from employees on Glassdoor (a site where employees can anonymously rate their place of work).

Cunningham receives an 89% approval rating from employees on Glassdoor, while the company as a whole receives a 4.2/5 rating from employees. This is all the more impressive when compared to the 3.2/5 employee rating for Coupons.com and 59% employee approval rating of CEO Steven Boal, or the 2.9/5 employee rating for Groupon and 61% employee approval rating of CEO Eric Lefkofsky. RetailMeNot makes a conscious effort to support and reward employees, and it shows in the company's superior ratings by employees on Glassdoor compared to its competitors.

Valuation and risks

The primary risks I see for RetailMeNot at this point are increased competition, whether from more established players such as Groupon or perhaps slightly smaller players like Coupons.com. I highly doubt that only one of these businesses will be successful in the coming years -- especially considering how quickly the digital marketing field is growing -- but it remains something to watch closely nonetheless.

The company’s stock-based compensation is another item to watch closely. Since the company just IPO’d last year this number is a bit tricky to track, but if stock-based compensation expenses continue to rise at a quick rate (it more than doubled year-over-year to $5.01 million in the first quarter of 2014) I will be more concerned and reevaluate my thesis. I don’t mind if margins are pressured by product development costs in the short-term, but I don’t like the idea of stock-based compensation being an ongoing drag on margins in a severe way.

So far as valuation goes, the recent decline of the stock -- due to largely unfounded fears of the Panda 4.0 algorithm update from Google -- presents what strikes me as an opportunity for patient investors. RetailMeNot continues to grow by leaps and bounds, increasing retailers and users on its network, and is also steadily increasing average revenue per visit to its site. All of these are great trends for investors and I expect will help the company continue to grow nicely in the coming years.

I believe the company can expand sales at an average pace of 30% annually for the next three years -- and likely can maintain comparable revenue growth rates (between 25%-30%) on average over the next five years -- in which case the stock will likely outperform the market. With the recent drop in share price I think RetailMeNot is poised to deliver average returns of approximately 15% annually over the next five years. I will continue to follow the company and update my thesis as necessary, but as it stands I am confident in the likelihood of RetailMeNot to outperform the market over the next five years.

Foolish bottom line

"We believe we're in the very early stages of a large market opportunity as retailers increase their use of digital marketing solutions to engage consumers," said Cunningham during RetailMeNot's most recent conference call. I am inclined to agree. RetailMeNot is poised to benefit from the confluence of two major trends: increased smartphone adoption and growing amounts of marketing dollars specifically allocated to digital marketing.

With a business model appealing to customers (through deals and discounts), retailers (by offering access to a growing and engaged consumer audience), and employees alike, I like the company's chances of expanding over the long haul and outperforming the market in the process (thus also adding shareholders to the list of grateful stakeholders). Welcome to the Pencils IRA Project, RetailMeNot.

This was a really well-written pitch. I have been using RetailMeNot for years - I learn today that I probably started soon after their founding - but I hadn't known about the mobile app or its 'beacon-like' features. A lot of other people I know also use it. It's useful. It saves me money and makes me feel like a retailer hasn't cheated me - it gives me a better feeling about the retail experience I'm having.

The technology appears pretty sound, and the numbers look pretty sound, and certainly the biographies of the C-level folks you describe are pretty sound as well.

I think the most intriguing question about a company like this is: can it stay independent?

How could it, at these valuation levels? Google, Apple, Microsoft or Yahoo could acquire this company more quickly than their CEOs could sneeze. The technology and the engaged userbase could immediately start to benefit any of these 4, and any of these 4 could use their size, technology and existing relationships to immediately leverage and deploy the technology worldwide.

Thanks for the comment and sharing your experiences. I wouldn't be surprised to see RetailMeNot get acquired by one of the bigger players that you mentioned. This space is sure to attract new entrants given the rapid growth of mobile/digital marketing as well as increased utilization of coupons and discounts.

RetailMeNot becomes an especially appealing target given its engaged and growing network of users and retailers around the globe. I hope the company is able to stay independent, of course, because of its innovative leadership and extensive long-term potential. If a buyout were to occur, though, I would anticipate a nice premium for shareholders.